China Dongxiang (Group) Co., Ltd. (HKG:3818) shareholders have had their patience rewarded with a 29% share price jump in the last month. Unfortunately, despite the strong performance over the last month, the full year gain of 2.9% isn't as attractive.

Following the firm bounce in price, given close to half the companies operating in Hong Kong's Luxury industry have price-to-sales ratios (or "P/S") below 0.6x, you may consider China Dongxiang (Group) as a stock to potentially avoid with its 1.1x P/S ratio. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the elevated P/S.

What Does China Dongxiang (Group)'s P/S Mean For Shareholders?

China Dongxiang (Group) could be doing better as its revenue has been going backwards lately while most other companies have been seeing positive revenue growth. One possibility is that the P/S ratio is high because investors think this poor revenue performance will turn the corner. If not, then existing shareholders may be extremely nervous about the viability of the share price.

What Are Revenue Growth Metrics Telling Us About The High P/S?

The only time you'd be truly comfortable seeing a P/S as high as China Dongxiang (Group)'s is when the company's growth is on track to outshine the industry.

Taking a look back first, the company's revenue growth last year wasn't something to get excited about as it posted a disappointing decline of 8.8%. This has soured the latest three-year period, which nevertheless managed to deliver a decent 15% overall rise in revenue. So we can start by confirming that the company has generally done a good job of growing revenue over that time, even though it had some hiccups along the way.

Turning to the outlook, the next year should generate growth of 11% as estimated by the one analyst watching the company. That's shaping up to be similar to the 12% growth forecast for the broader industry.

With this information, we find it interesting that China Dongxiang (Group) is trading at a high P/S compared to the industry. Apparently many investors in the company are more bullish than analysts indicate and aren't willing to let go of their stock right now. Although, additional gains will be difficult to achieve as this level of revenue growth is likely to weigh down the share price eventually.

The Bottom Line On China Dongxiang (Group)'s P/S

China Dongxiang (Group)'s P/S is on the rise since its shares have risen strongly. We'd say the price-to-sales ratio's power isn't primarily as a valuation instrument but rather to gauge current investor sentiment and future expectations.

Analysts are forecasting China Dongxiang (Group)'s revenues to only grow on par with the rest of the industry, which has lead to the high P/S ratio being unexpected. The fact that the revenue figures aren't setting the world alight has us doubtful that the company's elevated P/S can be sustainable for the long term. This places shareholders' investments at risk and potential investors in danger of paying an unnecessary premium.

Plus, you should also learn about this 1 warning sign we've spotted with China Dongxiang (Group).

Of course, profitable companies with a history of great earnings growth are generally safer bets. So you may wish to see this free collection of other companies that have reasonable P/E ratios and have grown earnings strongly.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.
This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.